More shuffling than growth

Tenants are extending leases and trading up as area absorbs a glut of space

Compared with last year, Richmond’s commercial real estate market is like a train going down the track. It’s slowly picking up steam. Downtown, a recently completed $62 million office tower graces the city’s skyline — the new home of law firm Williams Mullen. Out in the ‘burbs, a glut of empty space — caused by the closing of several major employers — is beginning to fill. And the region continues to see investment in new buildings by health-care organizations and private educational institutions.

But don’t expect the red, hot sparks of a full recovery anytime soon. While real estate companies report more prospects, there’s still a bit of softness in the market as the economy hobbles along without creating many new jobs.

The good news? Many businesses are extending leases or trading up to better space. In fact, real estate executives say there’s a big shuffle under way as companies and stores move, and new players come in to take their space. “There’s not a whole lot of net growth. People are taking advantage of the market to move up from B to B+ or A space,” says Steve Gentil, chairman of Grubb & Ellis/Harrison and Bates.
For instance, Swedish Match North America, a cigar and snus manufacturing company with an office in suburban Chesterfield County, is negotiating for 25,000 square feet of space in a high-end downtown location: a portion of the 100,000 square feet left vacant at Two James Center when Williams Mullen moved.

BB&T recently left downtown’s First National Bank building for classier digs a few blocks away in the West Tower of Riverfront Plaza.
On the retail side, Kroger and Costco closed old locations to build modern stores at different sites. In July, Cincinnati-based Kroger opened one of the largest stores in its entire chain — 92,000 square feet — across from Short Pump Town Center in western Henrico County. “The story is that the users are driving the market,” says David Crawford, an assistant vice president for the Richmond office of CB Richard Ellis.
His company took advantage of a tenant-favored market to lock in on a good deal when it was forced to relocate in August before a sublease expired. CB Richard Ellis moved from Forest Drive in Henrico into a new office building a few miles away at Reynolds Crossing. ‘It was an excellent time to move,” says Joseph P. Marchetti Jr., the office’s managing director. While the company didn’t expand its space, it enjoyed other advantages. “We got a market rate based on the economy, and we moved into a longer-term lease with more stabilized occupancy costs in the nicest building in the West End.”

Thalhimer, a large commercial brokerage with a Richmond headquarters and five other Virginia offices, also jumped at the chance to move out of leased space. In December, it’s leaving downtown, where it has operated since 1913, for the former S&K Famous Brands Inc. corporate building on West Broad Street in Henrico County. Thalhimer’s development subsidiary, TGM Realty Investors, purchased the former office, warehouse and a retail store at a bankruptcy auction last year for $5.8 million. The price for the 8-acre parcel in the fast-developing Short Pump corridor was not too far above its assessed value of $4.1 million, and was much lower than some of the area’s other prime parcels.
CEO Paul Silver says the firm plans to spend millions more renovating the site into an 85,000-square-foot mixed-use project for a total investment of about $11 million. The complex, located at the intersection of Interstate 64, already has lined up other tenants and will be fully leased, he adds. Thalhimer plans to take 25,000 square feet. Stratford University is leasing 52,000 square feet for its first Richmond-area campus and TD Ameritrade will take the rest of the space.

Silver says financing came from a local bank, Franklin Federal Savings and Loan. “If things are well located and leased, there are opportunities to get lending.”

Still, he remains wary of the market’s performance this year. “2010’s success will be if we don’t have further deterioration of occupancy and rental rates,” he says.

According to local market reports, the Richmond market saw signs of a recovery in the first quarter, but action slowed in the second quarter with an uptick in office vacancy. The reports show an overall office vacancy ranging from 11.6 percent (according to Thalhimer) to 18.4 percent (CB Richard Ellis).

In addition, the net change in occupied square feet for all properties in the second quarter turned negative. At midyear, Thalhimer put direct absorption at a negative 347,000 square feet. Yet that’s a big improvement over the more than 1 million square feet of space dumped on the market last year, with the closing of Circuit City Stores, LandAmerica Financial Group and Qimonda.

Circuit City, LandAmerica and the relocation of Wachovia Securities to St. Louis pushed vacancy in the Innsbrook corridor to more than 30 percent. Since then, some of the space has been leased or bought, with the vacancy rate dropping to 25 percent by the second quarter.
One of the biggest deals closed in July when Capital One Financial Corp. bought two buildings with 200,000 square feet of space for $17 million, or about $85 per square foot. Innsbrook Center I and II formerly were occupied by Wachovia. With this large vacant block off the market, the vacancy rate for Innsbrook Corporate Center dropped from 16 to 12.5 percent, according to Highwoods Properties Inc., which owns most of the center’s buildings. Meanwhile, the rate for the overall Innsbrook corridor dipped to 22.3 percent.

Innsbrook also can claim some of the area’s largest lease signings — in the neighborhood of 30,000 to 35,000 square feet — to such companies as Ironworks Consulting and Dominion Due Diligence.

Overall, executives say leasing activity is on pace with last year, although tenants are demanding longer leases. “Lease terms used to be for three years or less. Now we’re seeing leases go out five years or more,” says Marchettii. “Tenants are trying to hedge what they know will be increased operating costs down the road because of inflation.”

Despite the fragile economy, demand for medical office space continues to grow. “Health care has been a bright spot,” observes Silver. Bon Secours is investing $30 million for a new ambulatory-care campus in Chesterfield County. The nonprofit health system bought 15 acres at the Watkins Centre, where it plans to build a 200,000-square-foot center that’s expected to create 100 jobs.

Last month, Lingerfelt Development announced two more projects: a $25 million, 70,000-square-foot specialty center for sports medicine and rehabilitation in Chesterfield and a $4.2 million headquarters building for two health-care organizations in Henrico. HCA’s Virginia CJW Medical Center and West End Orthopaedic Clinic are joining forces to build the larger center. Some brokers expect more activity in this sector as health-reform legislation increases the number of people covered by health insurance.

Yet even with the boost from health-care providers and private educational institutions such as Stratford and South University — which recently built a campus in Short Pump — commercial real estate is not totally out of the doldrums.

While Thalhimer reported an increase in office leasing activity of 24 percent in the second quarter in Richmond — from 655,000 square feet in 2009 to 815,489 square feet in 2010 — those figures pale in comparison with levels before the recession. Thalhimer says its volume of leasing in 2006 was 1.7 million square feet and 1.4 million in 2007.

Mid-year figures for CB Richard Ellis showed 201 transactions this year of 1.4 million square feet valued at $3 million. For the same period in 2009, the firm had 200 transactions of 1.8 million square feet, valued at $2.7 million.

Going forward, Brian Glass, a senior vice president with Grubb & Ellis/Harrison & Bates, expects to see development “that will be very targeted and will be generated by the needs of specific users.”

For the region’s market to really take off, some officials would like to see more regional cooperation, especially on big projects such as Richmond’s port, high-speed rail and a more vibrant downtown core. “If we don’t get high-speed rail to Washington,” says Marchetti, “Richmond is going to be left behind in terms of growth in the mid-Atlantic corridor.”